What to do with SIPs now??

From Alok Sud

Since January this year the markets have seen erosion of stock values by a third on an average. In sectors like real estate and infrastructure the cut has been much deeper. The high inflation and the ever-rising crude oil prices have compounded the already grave situation even further. The collapse of Bear Stearns, Lehman Brothers, Merrill Lynch, AIG and many more in the pipeline has not helped matters one bit and the sentiment appears to be at all-time low. The phenomenon is not restricted to the US, even Russia, Europe, China and South Asia has seen massive erosion in stock prices. The Insurance, Banking and the financial sector are on life-support systems almost around the world.

In contrast the RBI and other statutory and regulatory bodies like SEBI, IRDA etc have done a commendable job of managing the crisis and not allowing the confidence of the people to be shattered. Elsewhere we have seen runs on many banks, long queues for redemptions of invested amounts in Mutual Funds and Unit Linked Insurance Plans (ULIP) etc. The interest rate on US Treasury Bonds has dropped to an all time of 0.61 % per annum, which is lower than the 2% interest rate on Bank Fixed Deposits. So deep is the mistrust of the banking system that no one is making any Fixed Deposit. This is despite the insurance cover of US $100,000 per bank account that is in place in the US, payable in case of the collapse of a bank.

I have been asked by some of my younger friends about what one should do to one’s investments in mutual funds through the Systematic Investment Plan (SIP) route. Should one continue or buy more units or stop buying fresh units or exit altogether?

I hadn’t thought much about the issue and when confronted with this query I decided to study the issue in greater detail. I wanted to give an answer that would be seen as rational upon closer scrutiny and not harm the financial interests of friends.

I gathered data of six MF and ULIP schemes where I have some exposure and studied the quotes from July 2007 onwards till date. The basic investment has been kept at Rs 4,000 per month. An investor had two options when he started investing in July 2007. He could either invest a fixed sum per month or buy a fixed number of units per month. When the market crashed in January 2008 he again had two options. He could either continue as before or cash out. I have not analyzed the cash out option since cashing out at an all time low causes maximum loss and no other avenue appeared attractive.

Based on my analysis I can confidently say that continuing to make the SIP investments at the same rate as before would afford the best protection for one’s long term wealth in such times. The investor ends up picking up more number of units at subdued rates, which allow the average acquisition rates to be the lowest in this scenario.

The low average acquisition price allows one to exit at any time with minimum loss in a market heading downwards and maximizes gains in a market going up. So all my friends out there, who doubted their decision to stay invested in SIPs in these turbulent times wondering if they did the right thing, can let their minds rest. You would have the last laugh after all.